Abstract
This research studies the relation between audit firm choice and benefits that companies could gain in terms of lower cost of debt and ea rnings management. It focuses on private clients and the non-Big4 audit market segment, where the main driver of auditor choice has not to date been satisfactorily identified. This study identifies and tests a new criterion for auditor choice in private firms based on audit market boundaries (European vs Domestic audit firms). Using a propensity score matched sample of private companies audited by non-Big4 audit firms in the period 2010 – 2014, this research finds that the choice of a European audit firm is negative ly associated with cost of debt and earnings management. Private firms that choose audit firms operating at European level, as consequence, have lower cost of debt and earnings management, mitigate the agency conflicts between lenders and owner/manager, and improve their corporate governance mechanisms. Key words: Audit firm choice, non-Big4, cost of debt, earnings management, private firms.
Highlights
The non-Big4 private clients’ audit market segment is an interesting topic: the Green paper (European Commission, 2010) for example, is against the concentration of audit market and aims to favor the development of non-Big4 audit firms:“The Commission recognizes that continuity in the provision of audit services to large companies is critical to financial stability
Given the gap in the previous literature that show that the current criterium to choose an auditor based on size is not sufficient among non-Big4, this study suggests a criterion based on the European boundaries of the audit market, showing its effectiveness in the reduction of Cost of Debt (CoD) and Earnings Management (EM), as an opportunity for clients to mitigate the agency conflict between lenders and managers in private firms through the choice of an European audit firms (EAF)
From the traditional criterion based on size of audit firms (BigN vs non-Big4), that could not be effective in the non-Big4 setting, we find that audit firms that operate at European level allow the lowering of CoD and EM, given the higher reputation and quality of these audit firms compared with domestic audit firms (DAF)
Summary
“The Commission recognizes that continuity in the provision of audit services to large companies is critical to financial stability. To this extent, options such as the ramping up of the capacities of non-systemic firms and exploring the pros and cons of "downsizing" or "restructuring" systemic firms should be further examined. Given the gap in the previous literature that show that the current criterium to choose an auditor based on size is not sufficient among non-Big, this study suggests a criterion based on the European boundaries of the audit market, showing its effectiveness in the reduction of CoD and EM, as an opportunity for clients to mitigate the agency conflict between lenders and managers in private firms through the choice of an EAF. The higher audit quality offered by EAF reduces risks related to earnings management and allows lenders to accept lower level of interests with benefits for all stakeholders
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